Australia’s RBA Sets Stage for Another Rate Cut

Australia’s central bank has cut interest rates seven times since late 2011, trying doggedly to support the economy as a once-in-a-century mining boom fades. But it hasn’t been enough, and the policy board is poised to ease further when it meets Aug. 6.

The RBA’s last cut, in May, took rates to a record low of 2.75%. But economic activity remains weak, unemployment is creeping higher and the local currency – despite falling more than 10% against the U.S. dollar in recent months – remains a brake on activity.

Add a dash of political uncertainty — elections must be held by the end of November, but Prime Minister Kevin Rudd has yet to set a date – and it combines to create a stagnant business environment.

On Tuesday, RBA Gov. Glenn Stevens set the stage for a rate cut in remarks to a Sydney business audience.

Past cuts are starting to encourage more risk taking in the economy, he said — but not so much “that we see a serious impediment to further easing.”

Inflation data last week showed the Australian dollar’s decline is beginning to drive up import prices. But that’s being offset by falling wages, meaning inflation also wouldn’t be a barrier to cutting.

“We have been saying recently that the inflation outlook may afford some scope to ease policy further if needed to support demand,” Mr. Stevens said. “The recent inflation data do not appear to have shifted that assessment.”

Markets now are drawing the same conclusion. Since mid-July, when interest-rate futures were pricing in a 50% probability of an August rate cut, the odds had risen to 85% by Tuesday.

To be sure, there are some bright spots in housing, with property prices firming and the construction pipeline for new homes improving. Data out Tuesday, however, showed the number of home building permits fell sharply in June, damping one of the few signs that easier policy was helping boost a lackluster sector of the economy.

One benefit of another cut would likely be further weakness in the Australian dollar. The Aussie has spent much of the last three years above parity with the U.S. dollar, and despite its recent decline almost to US$0.90, it remains well above its long-term average around US$0.75. That’s crimping businesses and making consumers reluctant to spend.

Even the government’s budget looms as a headwind to growth.

Adam Boyton, Deutsche Bank’s chief economist for Australia, said the government’s assumptions were too optimistic, ignoring sharp falls in commodity prices. Growth forecasts announced in May will have to be revised down substantially before the elections, he said.

“Treasury has consistently been too optimistic on the economy. Revenue therefore has had to be revised down and the government has had to scramble for savings,” Mr. Boyton said.

Treasurer Chris Bowen last week again committed the government to restoring a budget surplus in coming years. Given the current deficits, that implies spending cuts will be coming. Some media reports estimate the government will face a revenue shortfall of A$20 billion over the next four years.

With the flagging economy likely to take center stage in the run-up to elections, the RBA has only a narrow window to sneak in another cut before campaigning begins in earnest. Look for them to take advantage of that window on Aug. 6.

About Real Time Economics

Real Time Economics offers exclusive news, analysis and commentary on the U.S. and global economy, central bank policy and economics. Send news items, comments and questions to the editors and reporters below or email realtimeeconomics@wsj.com.